No green card? No exit tax problem

You should subscribe to The Friday Edition newsletter. This is the email that went out earlier today. You can ask international tax questions here, and we answer when we can. This week, it's about your green card and exit tax.

This Week's Question

This week's question comes from a tax lawyer I know in Germany, Daniel Hayden. Thank you, Daniel. Here is his question:

I have a short'n'easy (as tax law usually is) follow-up question to this week's q&a: will years, which a tax payer spend in the U.S. with a "normal" visa (not a green card) count as years when determining long term residency? For example: a taxpayer lives in the US with several subsequent regular visa for 10 years, then finally gets his greencard stays another 2 years and then leaves and files I-407 in the same year. Was he a long term resident and his he now a covered expatriate?

Short answer: this person will not be a "long-term resident" for exit tax purposes and cannot be a "covered expatriate", even if he is fabulously wealthy, pays millions in U.S. tax every year, and never filed a tax return. :-)

Overview

The exit tax rules apply only to "expatriates". Someone who is an "expatriate" must do some paperwork but owes no immediate income tax to the United States upon termination of U.S. citizenship or permanent resident status.

Only U.S. citizens and "long-term residents" can be expatriates. Let's ignore citizens for this discussion, just to keep focused.

One can only become a "long-term resident" by holding a green card visa. One cannot become a "long-term resident" by spending too many days in the United States--with or without a valid visa. If you are not a long-term resident, you will not file Form 8854, and you will not face the possibility of paying the exit tax, no matter how long you live in the United States.

Noncitizens Who Become Resident Aliens

Let’s talk about people who are not U.S. citizens, and their exposure to the exit tax problem.

A noncitizen of the United States can become fully responsible to pay U.S. income tax in one of three ways. Satisfying one of these will make the individual a “resident alien” fully taxable in the United States on worldwide income:

• By getting a green card visa and entering the United States. The visa status is the key determinant here.
• By spending too many days in the United States. Physical presence in the United States is what causes resident tax status.
• By making an election to be a U.S. taxpayer. A voluntary choice to be a U.S. taxpayer is obvious and self-evident.

People who do one of these three things are defined as "resident aliens" for tax purposes. They are aliens because they are non-citizens of the United States. They are residents because they did one of the three things listed to attain tax-residency status.

It would seem that the exit tax rules apply to anyone who is a U.S. taxpayer and ceases to be one. If you are in the U.S. income tax system and you want to escape, you should be taxed as you head out the door, right?

Noncitizens Who Face the Exit Tax

No. Not everyone is taxed as they leave. Only green card holders are taxed. Someone who is a U.S. taxpayer because of spending “too many” days in the United States can terminate U.S. taxpayer status without triggering Form 8854 and the exit tax rules. Someone who elected to be a U.S. taxpayer can terminate that election without triggering Form 8854 and the exit tax rules.

The key lies in the definition of "expatriate" in the exit tax rules. The definition is tied to a person's holding of a specific type of visa. If the person does not hold that visa status, then he or she cannot be an "expatriate". Since only expatriates can be "covered expatriates" (the people who pay exit tax), avoiding that visa status means avoiding the unpleasantness of the exit tax.

“Expatriate” Defined

An “expatriate” is defined in Notice 2009-85 as follows:

Section 877A(g)(2) provides that the term “expatriate” means (1) any U.S. citizen who relinquishes his or her citizenship and (2) any long-term resident of the United States who ceases to be a lawful permanent resident of the United States (within the meaning of section 7701(b)(6), as amended). Pursuant to section 877A(g)(5), a long-term resident is an individual who is a lawful permanent resident of the United States in at least 8 taxable years during the period of 15 taxable years ending with the taxable year that includes the expatriation date.

It is the second definition that matters to us. If the individual is a “lawful permanent resident” then it is possible that he/she will be a “long-term resident”. Counting years will tell us the “long-term” part.

“Lawful permanent resident” as a term of art used here is not the same as “resident alien”, the definition that makes a noncitizen into a U.S. income tax payer. That is why two of the three ways to become a “resident alien” (spending too much time in the United States or making an election to be a U.S. taxpayer) will not matter for exit tax purposes.

"Lawful Permanent Resident" Defined

Since the definition of "expatriate" is tied to being a “lawful permanent resident”, let us now look at that phrase. Internal Revenue Code Section 7701(b)(6) says:

. . . [A]n individual is a lawful permanent resident of the United States at any time if—

(A) such individual has the status of having been lawfully accorded the privilege of residing permanently in the United States as an immigrant in accordance with the immigration laws, and

(B) such status has not been revoked (and has not been administratively or judicially determined to have been abandoned).

An individual shall cease to be treated as a lawful permanent resident of the United States if such individual commences to be treated as a resident of a foreign country under the provisions of a tax treaty between the United States and the foreign country, does not waive the benefits of such treaty applicable to residents of the foreign country, and notifies the Secretary of the commencement of such treatment.

The important point here: an individual has been awarded the immigration status of living in the United States permanently as an immigrant. This status is determined under immigration law, not tax law. If this status exists and has not been revoked, then the person is a “lawful permanent resident” for tax purposes.

“Lawful permanent resident” used in this discussion is tax law jargon, not immigration law jargon. Confusingly, you will find the Department of State uses the phrase “lawful permanent resident” or “legal permanent resident” too, but it means something else when they use that phrase.

This means that our next quest is to find out what it means (under immigration law) for an individual to have been “lawfully accorded the privilege of residing in the United States as an immigrant”. We now move to the part of the discussion where we prove that only “green card” holders (I’m using street language here, not technical definitions from tax or immigration law) can be immigrants. Or more simply, the only visa that makes you an “immigrant” is the green card. All other visas are “non-immigrant” visas.

I’m not going to go through the Federal law (immigration and tax) and the accompanying regulations. It’s hot, I’m bored, and so I’m going to quote from the IRS website, where they try to tell you what it all means. The IRS defines “immigrant” as follows:

An alien who has been granted the right by the USCIS to reside permanently in the United States and to work without restrictions in the United States. Also known as a Lawful Permanent Resident (LPR). All immigrants are eventually issued a "green card" (USCIS Form I-551), which is the evidence of the alien’s LPR status. LPR’s who are awaiting the issuance of their green cards may bear an I-551 stamp in their foreign passports.

Here, we have the connection between the phrase you and I use every day (“green card”) and the term of art used in the Internal Revenue Code (“immigrant”). An immigrant eventually receives a green card (USCIS Form I-551). A “lawful permanent resident” for the IRS is someone who has a green card and whose green card has not been taken away by the government.

If you do not have a green card, you’re not an immigrant. Everyone else holds a non-immigrant visa of one kind or another. Investor visas, L-1, student, O-1, and everything else. If you have one of these visas from the United States, you are not an immigrant. You are legally in the United States, potentially for decades or the rest of your life (whichever comes first) but you are not an immigrant.

Finally

We are at the point where we can show why only green card holders can be long-term residents, and only green card holders can be subjected to the exit tax. For immigration law purposes, an immigrant is a green card holder. For tax purposes, a lawful permanent resident is an immigrant (and green card holder) as defined for immigration law purposes.

Since only immigrants receive green cards, simple logic tells us that people without green cards cannot be immigrants. They are nonimmigrants even if they are living full-time in the United States.

Consider someone who lives in the United States for 10 years with an L-1 visa. The “long-term” part of the definition of “long-term resident” is satisfied. But the person is not a “lawful permanent resident” = immigrant = holder of a green card visa. The person is a nonimmigrant.

Therefore, upon leaving the United States, the person will not be an “expatriate”. Because the person will not be an expatriate, it will be impossible for the person to be a “covered expatriate”. Since the exit tax rules of Section 877A only apply to covered expatriates, the individual with an L-1 visa can leave the United States without thinking of the exit tax rules.

Daniel's Question

Back to Daniel's question. Someone is in the United States for 10 years with a visa that is not a green card. Unquestionably that person is a U.S. "resident alien" and will pay U.S. income tax on his worldwide income. Then the person gets a green card, holds it for two years.

The person was an "immigrant" (i.e., held a green card) in two of the last 15 years. He was a nonimmigrant (in the United States under some other visa status) for the prior 10 years. The person cannot be a "long-term resident" because of this fact. He can leave the United States without worrying about exit tax considerations.

Planning Considerations

For people who want to live in the United States, I encourage you to look first at any visa status except the green card. You can live in the United States for decades on a number of visas. Your tax status is far less treacherous than it is if you get a green card.

This may make a path to U.S. citizenship more difficult. Your intention may indeed be to live in the United States for the rest of your life. If these considerations are more important than tax, then by all means pursue the green card. But if there is a possibility that you may leave the United States after a while, I think you should look at alternate visa strategies.

For people who currently have green cards, the only way to avoid the exit tax is to avoid the "in 8 of the last 15 years" rule that converts them from merely resident to "long-term resident" status, and subject to the exit tax rules. Around year six you should make some hard decisions, and if necessary make plans to leave the United States if avoiding the exit tax is important to you.

Not Legal Advice

Now of course is a prudent moment to remind you that this is not legal advice. Get competent immigration law advice on your visas. Hire someone to figure out the tax problems. Don't read my emails and think they're the gospel. :-)